Catalyst - Fall 2011 - Enterprise Risk Management

For Life Science entrepreneurs, balancing risk and reward has never been more challenging than it is today. Entrepreneurs are a special breed - combining vision and execution to achieve their just rewards. Managing the development and commercialization risk usually determines the success or failure outcome, or at least the timing and degree thereof. They typically add regulatory and clinical risks, and an uncertain pricing model, to these entrepreneurial risks, but the reward of improving lives of patients and the possibility of significant financial reward drive their vision forward.

Against the background of the global financial crisis and the still uncertain global economy, companies are re-invigorating their strategies for responding to the challenges and pressures of a new environment. Risk—and in particular the risk oversight function of the board of directors—has taken center stage, and expectations for board engagement with risk are at all-time highs. Effective organizations’ create a continuous process embedded within a company’s culture where managing risk is openly discussed and shared.

Enterprise risk management begins with the appointment of a champion, which is typically the CFO. The champion's role is to create a process to identify and assess risks but also to educate the organization and be a catalyst for change. Once the champion has established the tone, the first step in the process is to catalog the risks.

Knowing where to begin is a challenge faced by all executives undertaking a risk assessment. An SEC document or private placement is just a starting point for the development of an inventory of risks. The best method is to perform facilitated workshops with executives and management about their business plans (i.e., strategy) and the risks that might be encountered. It’s important to note that this process should identify both those risks that have a negative impact (loss), but also those risks having a positive outcome (opportunity). Sharing risks in an open forum like this also helps ensure that the organization sees the totality of the company's risk profile, as opposed to a silo view by any single function. This tends to improve employee ownership of company risks.

One of the best methods we have personally seen was developed by Craig Tooman, the lead company spokesperson to the financial markets and CFO at several pharmaceutical companies including Pharmacia, ILEX Oncology and Enzon Pharmaceuticals. He created and chaired a very effective Disclosure Guideline Committee, a group comprised of members representing all major functions of the company (R&D, marketing, sales, finance, accounting, HR, legal, IP, etc.). Attendance by each function was mandatory and the intent was to review all drafts of public communications in an open, non-threatening manner so all risks could be captured. According to Tooman, "The greatest part of these meetings is when each function comes prepared to discuss each other’s risks and opportunities. The enormous breadth of risk that a CFO or CEO is responsible for today calls for a means of capturing risks while they are still very manageable and before they escalate. The disclosure committee is the best way I have found to accomplish this as it requires sign off by every function prior to the CFO and CEO signing."

According to Tooman, "There is a continual and healthy tension between short- and long-term organizational objectives in the public company setting. To the extent that you have a strategy that is clear and known, it is much easier to communicate events along that strategic pathway. This is true of both positive and negative news. It is obviously much easier to communicate good news. Communicating challenging news is much more differentiating."

Although executives are paid to "know" and manage key risks, the ability to monitor risks, inform stakeholders and then adjust the business plans as necessary can prevent lost time and effort and sometimes irreparable damage. In a well thought-out process, the possible outcomes of critical activities would have already been modeled, and decisions made based upon most likely scenarios. Possible adverse outcomes, and the required redirection of the business plan, can be modeled, but the financial and time requirements of the re-direction are often uncertain until the actual data are received and analyzed.

External viewpoints can be another key way of capturing risks. Views on competition from analysts and investors can help avoid obsolescence and near term competitive risks. Scientific advisory boards can also steer R&D spending away from areas with little return. Board members, who often include members from venture capital and academic institutions, can also be important contributors in profiling risks and opportunities. These are often larger, "macro" like contributions but can have a profound impact on risk.

Another key step is to develop key risk performance indicators. The best practice, particularly at the executive and board levels, is to develop dashboard reports showing how the measurable risks are performing within an established risk tolerance band. Depending upon the environment, this dashboard may be weekly or monthly (sales, cash flow, production, etc.) or quarterly (financials, clinical progress, project development, etc.). We have seen quite a few companies utilize the reporting of quarterly results to also communicate important strategic updates to employees. Communication of the achievement of critical milestones and avoidance of key business risks helps ensure employee ownership of the company's strategy.

Finally, it is important to refresh the risk discussions with the key stakeholders on a regular basis. The ability to garner support and new ideas from leaders of an organization allows a continuous focus on the areas of greatest concern or opportunity. And throughout the process the overriding feature is the ability to finance the research or clinical or commercial operation at hand. We are seeing the emergence of “singularly focused just-in-time” financed companies, which underscore the aversion to risk in today’s capital markets --- and the resultant simplifying of development processes to a linear scale.

Funding of an organization can be a key risk, particularly in these very volatile markets. Good companies need to plan way ahead, and build a strategy that incorporates scenarios for funding risk. As many executives know, an immediate need for financing means the price to obtain it usually rises considerably.

Tooman, who has found financing for large and small companies notes, "There are obviously pros and cons to financing a narrowly focused company. On the positive side, it is a much easier story to tell to potential investors who may already feel diversified through their own portfolios. On the other hand, a more diversified company profile (including such things as products with current revenue in addition to a pipeline) naturally allows investors to hedge their bets a bit more. Part of the exercise is to match the profile of the company with profile of the investor - something that sophisticated companies do well. In the end, all companies want their good ideas to be well-funded."